You might not easily get this impression from Christine Lagarde’s understated delivery, but the European Central Bank she heads just became a lot more pugnacious vis-à-vis not only markets, but also the eurozone’s fiscal policymakers.
For quite some time the ECB has been visibly uncomfortable about being “the only game in town”. It was long left to the central bank to push monetary policy close to its limits to sustain aggregate demand, and to find legally watertight mechanisms to prevent speculative attacks on the euro’s integrity and its member government’s solvency.
Its decisions on Thursday — to raise interest rates by a higher-than-signalled half a percentage point and to introduce a new “Transmission Protection Instrument” bond-buying programme — turn the tables.
The rate decision was punchy and clearly intended to flex some monetary tightening muscle: markets should not expect the ECB to hesitate to curb inflation, the message seemed to be. But the TPI (to use the latest acronym in the bank’s arsenal) is by far the most interesting policy — and political economy — move.
The ECB has now taken it upon itself to stop sovereign borrowing costs from diverging too much from one another — if it judges the divergence to be “disorderly and unwarranted” and to interfere with its monetary policy stance. In plain language, that refers to panicky market sell-offs of sovereign debt when ECB monetary tightening leads investors to question what rising rates would do to a euro country’s debt dynamics.
The policymakers in Frankfurt have put those investors on notice. Lagarde’s press conference suggested that the spread widening the ECB has in its crosshairs is the self-fulfilling kind, where bond prices deteriorate for no other reason than market participants expect them to do so. One might put it this way: the ECB will not tolerate markets dynamics which, rather than reflecting economic realities, create their own. And it will intervene, without limits if necessary, to prevent this.
But it has put the rest of the EU’s governing system on notice too. The ECB’s eligibility criteria for using the new instruments draw heavily on the economic governance mechanisms in the European Commission and the eurogroup of finance ministers. Among other things, to shore up a country’s bonds under TPI, the ECB will look at whether the government in question is abiding by the commission’s and eurogroup’s recommendations. The central bank is telling elected leaders not to outsource essentially political judgments, daring them to own the decisions that determine whether a country should be protected against speculative attacks.
Without saying it in as many words, the ECB is belatedly making more use of its neglected secondary mandate. That mandate is often forgotten or outright denied. But subject to stabilising prices, the central bank is legally obliged by the EU treaties to support the bloc’s general economic policies. It is doing so while simultaneously reminding everyone who has the authority to say what those policies actually are.
Mario Draghi’s resignation as Italian prime minister on the same day puts the new dispensation of decision-making in stark relief. The ECB’s own criteria justify buying Italian bonds under TPI today, if it sees fit. By the end of the year, however, Draghi has said Italy needs to fulfil 55 policy actions to comply with the commitments in its EU-funded recovery plan — which the ECB has made a condition for TPI eligibility.
That will weigh on whoever takes over the reins in Rome in the next few months, and those in Brussels who have to assess their compliance. By promising to do its bit, the ECB has also cleverly passed the buck.
